The portfolio is up 11.85% in 2013.

It is time to execute our solemn duty and perform one of the most difficult tasks that any passive investor must face: rebalancing. Defying the screaming instincts of every nerve in our body we must cut our winners and embrace our losers.

The US may be up over 25% on the year, Japan over 23% and Europe over 20%, but no matter. We must trim back their rampant growth and cast the proceeds at UK Government bonds and Emerging Markets – 2013’s twin losers: down 3.20% and 9.43% respectively.

This act of financial self-flagellation demonstrates the iron discipline that passive investors require in the face of buoyant markets that are making even the humans look good, never mind the dart-throwing chimps.

The Slow and Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000 and an extra £750 has been invested every quarter into a diversified set of index funds, heavily tilted towards equities. You can read the origin story and catch up on all the previous passive portfolio posts here.

It sounds wrong – and it definitely feels wrong – to back the losing team with more of our cash, but this is the behaviour that is hopefully laying the foundations for our long-term success.

The rocketing prices of developed world equities are likely to reduce their returns in the future. In the long run valuations are tied to the fortunes of the global economy. If prices go on a happy juice bender, driven by blissed out investors and gallons of quantitative easing, then eventually economic forces will snap them back to reality.

In other words, returns will eventually revert to the mean.

I have no idea if equities are overvalued (though the US is certainly well above its historical average) or when prices will snap back. But the historical record tells us that at some point it will happen.

And when it happens, we won’t be sitting on a portfolio that’s all in on the most overvalued portions of the market.

Rebalancing is the positive habit that boosts your immune system over the long term. It’s the mechanical conscience that forces us to be good; making us down the cod liver oil of the cheapest markets – the source of strong growth in the future as they recover.

Rebalancing also keeps us diversified. One reason we allocated 24% of our asset mix to government bonds was to ensure a buffer when equities do hit the skids. Right now, our bond allocation has sunk to 20%. Time to plump it back up.

We use Larry Swedroe’s 5/25 rule to trigger rebalancing moves when markets swing wild. We also rebalance annually back to our target asset allocations and that’s what’s driving the sales you’ll see below.

That said, you can channel new contributions to your underweight assets too, and a combination of the two techniques helps us to make a bond purchase that’s four times larger than usual.

Remember, we’re not bailing out of any asset – nobody knows which will perform next year. We’re just respreading our bets to prevent excessive concentration in any one area.

Scores on the doors

Before we make our new purchases, let’s tally the portfolio’s vital statistics.

  • The portfolio is three years old and is up 17.23% since we started. That’s a £1,938 gain on total contributions of £11,250.
  • It’s equivalent to an annualised gain of 6.49% over the three years, according to Morningstar’s portfolio tracker.
  • The FTSE All-Share has gained 9.37% annualised in the same time period.

Our portfolio has lagged the All-Share because of our allocation to government bonds and because our later drip-fed contributions haven’t benefitted from the market’s near relentless rise over the entire three years. A lump sum dropped in three years ago would have done much better but that’s the way it goes.

Here’s the portfolio lowdown in spreadsheet-o-vision:

Up 17.23% since purchase.

In another piece of good cheer, our funds have paid out more than £125 in dividends this quarter, although every single penny is invested straight back into growing our accumulation funds, so we benefit from compound interest.

Now, we have two final pieces of annual maintenance to attend to.

First, we shift our target asset allocation by 2% every year from equities to bonds. As our time horizon diminishes (only 17 years left!) we practise the time honoured ritual of lifestyling – reducing our exposure to volatile assets as we get older and have less time on our side.

Hence we’re shaving 1% each from Japan and the Pacific in favour of a now 26% allocation to bonds.

Finally, we need to think about inflation. We started off investing £750 every quarter at the start of 2011. Three years later and £750 ain’t what it used to be.

We should now be investing around £827 to punch at the same weight, so let’s jack that up to £850 as I haven’t been conscientious about matching inflation so far and this investing lark seems quite fruitful after all.

New transactions

Every quarter we attempt to appease Mr Market with another £850. Our cash is divided between our seven funds according to our asset allocation.

However, this quarter I had to top up the UK and Pacific fund purchases as they didn’t comply with Charles Stanley Direct’s £50 minimum contribution for regular investing. I did this by shaving off £72 from the bond purchase. It’s not a perfect solution but then little is.

UK equity

Vanguard FTSE U.K. Equity Index Fund – OCF 0.15% (Stamp duty 0.5%)
Fund identifier: GB00B59G4893

New purchase: £50.66
Buy 0.2611 units @ 19403.7p

Target allocation: 15%

Developed World ex UK equities

Split between four funds covering North America, Europe, the developed Pacific and Japan1.

Target allocation (across the following four funds): 49%

North American equities

BlackRock US Equity Tracker Fund D – OCF 0.17%
Fund identifier: GB00B5VRGY09

Rebalancing sale: £269.88
Sell 204.6114 units @ 131.9p

Target allocation: 25%

OCF has gone down from 0.18% to 0.17%

European equities excluding UK

BlackRock Continental European Equity Tracker Fund D – OCF 0.18%
Fund identifier: GB00B83MH186

Rebalancing sale: £10.32
Sell 6.3098 units @ 163.6p

Target allocation: 12%

Japanese equities

BlackRock Japan Equity Tracker Fund D – OCF 0.18%
Fund identifier: GB00B6QQ9X96

Rebalancing sale: £136.61
Sell 103.5719 units @ 131.9p

Target allocation: 6%

Pacific equities excluding Japan

BlackRock Pacific ex Japan Equity Tracker Fund D – OCF 0.24%
Fund identifier: GB00B849FB47

New purchase: £50.55
Buy 24.7181 units @ 204.5p

Target allocation: 6%

OCF has gone down from 0.22% to 0.21%

Emerging market equities

BlackRock Emerging Markets Equity Tracker Fund D – OCF 0.28%
Fund identifier: GB00B84DY642

New purchase: £302.76
Buy 291.9585 units @ 103.7p

Target allocation: 10%

OCF has gone up from 0.28% to 0.29%

UK Gilts

Vanguard UK Government Bond Index – OCF 0.15%
Fund identifier: IE00B1S75374

New purchase: £862.85
Buy 6.8840 units @ 12534.15p

Target allocation: 26%

New investment = £850

Trading cost = £0

Platform fee = 0.25% per annum

Average portfolio OCF = 0.18%

If all this seems too much like hard work then you can always buy a diversified portfolio using an all-in-one fund like Vanguard’s LifeStrategy series.

Other asset allocation options include adding a high-grade corporate bond fund, an index-linked bond fund, BlackRock’s Global Property tracker and replacing the four developed world funds with Vanguard’s FTSE Developed World index fund. You could also use Exchange Traded Funds (ETFs).

Take it steady,

The Accumulator

  1. You can simplify the portfolio by choosing the do-it-all Vanguard FTSE Developed World Ex-UK Equity index fund instead of the four separates.

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